All men’s miseries derive from not being able to sit in a quiet room alone. – Blaise Pascal

Posted by: donmihaihai | August 10, 2008

Swimming against the tides.

Recession and slowdown in the economy is common and stock market will goes along as well. If one is so good at predicting the direction of the market, he will make lot and lot of money but for a person like me, who is very bad a sensing the directions, I can only buy strong company/swimmer who is able to swim into unexpected tides and come out unhurt.

Strong Swimmer – SP Chems

SP Chems reported a 2Q2008 that looks very strong on paper with 70% and 31% increased in NPAT for 2Q2008 and 1H2008 when the revenues increased 126% and 95%. This is a sharp turnaround from 1Q2008 when NPAT dropped 14% as revenues increased 61%. What are the reasons behind this swing of fortune?

The main reasons are:

1) Increase in production capacities for caustic soda, chlorine and Aniline by 50% from PP5 and commencement of VCM 200,000 tones production capacity in 1Q2008. With this, SP Chems production capacities should be double from last year. The increase in product prices is not the reason behind the in the surge of NPAT and revenues for long term, that only affect short term qoq or yoy results.

With these capacities commencement, SP Chems should be view as a bigger player, double that in FY2007. The cyclical nature and swing in product price and raw material can cause SP Chems NPAT to swing negative and positive as well. In fact, I won’t be surprise if SP Chems able to double FY2008 NPAT from FY2007 or having a flat NPAT for FY2008 even through revenues double.

2) Changes in depreciation periods for Chemical plants from 10 to 15 years and Co-generation plant from 10 to 20 years help by reducing COS and increasing GP. While it is possible that the changes in the depreciation periods is pushed by accounting policy but the thought of why SP Chems is doing it in FY2008 must not be push away too easily. Other than that, 15 and 20 yrs are very comfortable depreciation periods, while I am not sure about Chemical plants, Coal-generation plant is know to operate healthy for more than 20 years.

Before extrapolate the current results into 2009, it is good to look at the negatives:

1) No new capacities will come online until mid 2010. No new capacities = no growth in revenues and NPAT if product prices and expenses remain constant. If product prices and expenses swing to the wrong side, prepare for slump in NPAT.

2) China/US/global slowdown or even recession, whichever the case is, export and domestic requirement will slow as well, this is not good news because SP Chems products are basic chemicals that are widely use.

3) Increase in tax.

What ever the cases, I expect SP Chems to be a net beneficial with its strong B/S and cashflow as their weak competitors being hit left, right and central. At current price of $0.59, SP Chems is trading at about 6 X 2007 earnings and 1.2 X latest reported BV. Look cheap to me but it was cheaper in Mar 2008 when it traded at below $0.50.

Strong Swimmer – Celestial

After reporting a strong 1Q2008 results with revenues and NPAT surged 52% and 54% respectively, Celestial followed with another strong set of 2Q2008 results where revenues and NPAT increased by 37% and 12% respectively. This is achieve under difficult circumstances of high material price which is widely known, Sichuan earthquake and possible the freak snowstorm.

What are the reasons behind this set of good results? It is just simply increase in selling price across all their products and increase in capacities utilitisation.

Now it is negative time and there are alot.

1) Increase in selling price, especially consumer product are usually being says as having pricing power. But the question is how much more increment can Celestial push forward before hurting the demand of their products if raw material keeps increasing. This so call “moat” is a very weak one, and since many companies that I am looking at are passing the increment of raw material price to their customers, so they are all having a “moat”, be it some are stronger while other are weaker? I think this is a two steps equation. Passing of raw material is the 1st step but the 2nd step, where what is “moat” all about is that will the selling price stay or follow to drop if raw material goes down.

2) The results look good only when compare yoy, Celestial results look bad when compare qoq. 2Q2008 is the 1st time where 2nd quarter revenues were lower than 1Q. While Sichuan Earthquake may reduce the demand at that area causing revenues from health food and beverage segment to drop by about 7%, we can’t rule out the possibility that increase in price is starting to hurt demand. And GP is not encouraging.

3) One of the factors in the sustaining the profit margin is that Celestial is running up the production capacities. Economics of scale is in play here but when looking at P&L statement, accounting is playing a trick too, because depreciation remain the same, margin will increase when production increase.

4) I suspect the slump in profit margin of SPI segment will not regain back to the level few year back. And this will play out in their other industry products in the future as well.

5) Super profit of soybean oil will not continue. With GP margin at 34%, it suddenly become important to Celestial and contributes around 20% of Celestial GP margin where just 2 years ago, soybean oil is an insignificant by-product. If I take out Soybean oil from the contribution, Celestial will report drop in NPAT.

At $0.755, Celestial is trading at just below 6 X 2007 earnings and 1.3X latest BV. Celestial was once trade at around $0.55 which makes it selling at below last reported BV and 4.2X 2007 earnings. I have put Celestial into the China F&B cluster. Despite all the problems and difficulties they are facing, it has become my favourite sector. Cheap and good.

Stronger Swimmer – Bright World

Bright World recorded a 39% and 50% increased in revenues and NPAT for 1H2008 which is quite evenly spread out for 1Q and 2Q 2008. What a beautiful set of results.

How Bright World does it? Pretty simple and not complicated, selling more high performance stamping machine and passing the increase in raw material price to customer as Bright World lay out. I think it is true, whatever term they want to use it, for a machine/equipment manufacturer to has a bright future, it has to build machine that is reliable and keep improving on it so that they can sell them at a high price which is what Bright World trying to do except maybe selling at a higher price.

Going forward, what are the negatives?

1) Working Capital. I am not too worried about payables and in the environment of raising raw material price, Payables will be paid faster than receivables. The biggest headache is growing inventories and trade receivables and as Bright World is selling Machine kind of products, they can’t run away without investing quite abit in the inventories and receivables. It does not seem to be out of control yet as of now but if it continues it will.

2) Raising material price such as iron is on it way for a big increment and doesn’t seem to be coming down soon.

3) A slowdown will hit BrightWorld as well.

Why should we be cheering when someone offer a 100% premium of the then market selling price of BrightWorld as the company is going exceptional well? At $0.455, it trade at 6.4 X FY2007 earnings and 1.6 X last reported BV. And before any offer for Bright World is not the table, the lowest price BrightWorld recently traded was $0.36.

Swimmer – Full Apex

Full Apex reported revenues increased of 74% for 2Q2008 and 49% for 1H2008 while NPAT reduced by 8.3% and 1.4% respectively. While the results look pretty ok, not too good or bad, the biggest problem is to understand more about the performance of individual segment. The information is lacking at all quarterly results. But there are still some factors that influence the results.

1) Commencement of PET chip production which causes the increased in revenues but suboptimal plant utilisation at 50% is causing Full Apex to loss money as reflected in the results.

2) The surge in oil price from below USD100 to near USD150. Since the price of each bottle is negotiated before the start of every quarter with their customers, any sharp increased in oil price can possible to drag Full Apex into losses for that quarter. For this part, I think Full Apex is doing very well. Another point is that Full Apex gathers about 7 X of their required inventories at end 2007 where oil price is at double digit. The running down of inventories during 1H2008 helps Full Apex to handle increasing raw material cost.

3) Looking at operating profit before working capital changes show that Full Apex was generating higher profit before any changes in working capital. This is the clear evidence that Full Apex was not just holding on but actually generating higher profit. Accounting treatment does the trick of lowering the profits.

And the negatives?

1) High Oil price.

2) Growing of PET bottle production

3) Is there any tax issue? Everything that Full Apex reported look good and I don’t have any problem with their productions, inventories, receivables but the tax does not seem to be normal to me.

Again at $0.205 where the lowest was $0.20, Full Apex trade at 6.2 X FY2007 earnings and 0.7 X last reported BV. The current stock price is just saying, hey I don’t think you are still going to be in this businesses in the near future which is not the case. And in the business of PET bottling for giant consumer drink in China, those hard assets are going to worth much more than historical BV. Receivables are solid with inventories being good as well.

Swimmer – China Angel

Another stock from my favourite sector because it is cheap and good. Since I am looking forward for the market to present me a better price going forward. I don’t like to write much about this aggressive company. And I like the headline reported results for 2Q2008 and 1H2008. In 2Q2008, China Angel revenues increased by 16% but NPAT slumped by -161% which mean loss making. For 1H2008, China Angel revenues increased by 80% while NPAT dropped by 84%. At $0.14, China Angel is trading at 4.8X FY2007 earnings and just below BV. Well China Angel share price slump to $0.12 at one point sometime back.

All China Stocks, all are swimmer that able to swim against the tides. It doesn’t matter what happen to China or globe in short term. All should come out unhurt or even in a better position against their competitors. And At this kind of stock price, I don’t see why predicting the direction of the stock market is so important.

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Responses

Hi, I read about your comments on Full Apex which is very interesting. BTW, on 10 July 08, 35,310,000 shares was traded for Full Apex… Do you have any information about the spark of such big volume traded? Thanks.

Mr Jordan Hou, ex. executive director is pretty much related to Australia but I don’t know whether his family live there or not. BUT, CEO singled him out 2 AGM ago that he was in charge of the new PET chip plant. So 1) Did he perform badly? 2) Or he finally finished his job and rejoin his family?

Thank you for agree with me. And I like stock that no one like or keen.